Fed Sparks Emerging Markets Party, But It’s Unlikely to Last

The U.S. Federal Reserve’s surprise decision not to scale back its bond purchases has sparked a rally across emerging market assets, offering some respite after a bruising year so far. But the Fed’s largesse is unlikely to spark an indiscriminate buying spree across developing markets as investors are likely to increasingly differentiate between stronger and weaker emerging markets.

Bargain-hunting fund managers had already began picking through the emerging market rubble, looking for markets where the summer sell-off looked overdone. Once the initial Fed-induced bounce is out of the way, countries with shaky finances could find the market’s unfriendly gaze on them again.

Here’s what some money managers had to say about emerging markets:

Viktor Szabo, portfolio manager at Aberdeen Asset Management, which has $10 billion in emerging market assets, said the Fed’s decision hasn’t changed his view that 10-year Treasury yields will likely rise towards 4% in the long run.

“While we could see short-term relief in places like Turkey and India, the risk is that policymakers will become complacent and not implement the structural reforms needed to make their economies competitive. Countries with current account deficits need higher interest rates to cool domestic demand and there is a possibility that the Fed’s actions may prompt certain central banks to hold on from tightening monetary policy,” Mr. Szabo said.

“We are looking to add to positions through auctions or sale of new bonds but just where we are comfortable with the issuer and the issuance price. For instance, we are looking to participate in the Armenian bond sale today and bought South African dollar bonds at the start of the month,” he added.

Paul McNamara, who oversees $7.5 billion of emerging market debt at GAM, said the FOMC delivered a “bona fide surprise” which it will take a while for the market to price in.

“The market has moved a hell of a lot, particularly in our space, but I doubt this is over. I think people will put money into stuff that has sound fundamentals. Right now, Turkey and India are leading, but I think only the sound stuff will keep going in the longer term, like Poland and Mexico,” Mr. McNamara said.

“I don’t think we now go back to where we were in May. The current-account deficits are bigger and there’s more domestic debt. We’ve bought a bit of zloty and a bit of Mexican peso. We favor the stuff we like, not the stuff that’s moving,” Mr. McNamara added.

JPMorgan Asset Management, which oversees around $370 billion of bonds, bought a few emerging market bonds in the run-up to Wednesday’s FOMC announcement as valuations began to look increasingly attractive, said portfolio manager Iain Stealey. The unexpected decision by the Fed not to pull back has further cemented his view that debt issued by countries with sound fundamentals looks cheap.

“There’s still going to be some value to be had in emerging markets. The aggressiveness of the sell-off means you don’t need to catch the first couple of per cent on the way back up. Mexico ticks quite a few boxes as does Russia, given the solid fiscal positions,” Mr. Stealey added.

“We are unlikely to reach the previous lows in yield as risks in some emerging countries are in sharper focus now, than say at beginning of the year, and the recovery in developed markets is still ongoing. Some emerging markets were oversold, and already seeing some retracement even before last night.” said Mr. McDonagh.